Deduction of IP‐related litigation expenses

Typically, litigation expenses may only be deducted in terms of s11(a) of our Income Tax Act. However, this section specifically excludes expenditure that is capital in nature.

Intellectual property (IP) is by its very nature a monopolistic right, granted by law. In general, IP is used to protect market share and preserve one’s market from potential competitors. It is therefore clearly a capital asset, i.e. forming part of the income earning structure as opposed to the income earning operations of a business. Put another way, IP is the tree from which the fruit of royalty payments or sales is derived.

In the case of Cadac Engineering Works 1965 (2) SA 511 (A), the taxpayer wished to claim s11(a) deductions for expenditure incurred in obtaining an interim interdict based on infringement of patent rights. In its judgment, the Court held:

"[the purpose of the expenditure was to] protect, and perhaps expand the taxpayer’s existing market and goodwill. The expenditure was directed towards preserving and perhaps expanding, the field in which the taxpayer’s business operation. In short, the expenditure was incurred in order the better to exploit the taxpayer’s existing capital assets, which latter included the exclusive licence to manufacture the Marcovitch cooker … Money expended in buying out a competitor will, I think, ordinarily fall into the category of capital expenditure."

Accordingly, IP related litigation expenses may typically not be deducted in terms of s11(a), but the litigation cost should be added to the base cost of the IP asset for CGT purposes.

Having regard to the strong capital nature of IP and the principles in Cadac Engineering, it is difficult to imagine any instances where IP‐related litigation expenditure would be considered anything but capital in nature.

Also see Stellenbosch Farmers’ Winery ’45 CPD 377.

(Updated 2007)

Articles: Taxation